Expert Commentary

The State of Wrap-Ups 2008

It has been a while since we last addressed the state of wrap-ups. Well, no doubt, it is a very timely subject with several factors contributing to the current dynamics of the wrap-up phenomenon. Let us first recognize that regardless of what is addressed in my article, the state of wrap-ups in 2008 is very good, but we do face certain challenges as the wrap-up paradigm continues to evolve.


Wrap-Up Programs
April 2008

The past 5 years has seen a substantial growth of controlled insurance programs. This had a lot to do with our expanding economy, the demand for residential housing, troubling coverage limitations in the contractor marketplace, escalating contractor rates, and a tightening marketplace for "owner's interest policies." All these paradoxes made for very compelling "pro" wrap-up arguments.

This is not to say that 2008 will see a dramatic drop off in wrap-ups, but we need to be cognizant of several forces working against us. We may need to be smarter and understand what truly motivates buyers of wrap-ups. The factors we need to address as critical to the state of wrap-ups are:

  • The economy and sub-prime mortgage crisis
  • The current wrap-up marketplace
  • Contractor rates and wrap-up feasibility

The Economy and Sub-Prime Mortgage Crisis

It should come as no surprise to anyone that the current credit crisis caused in large part by the overall sub-prime dilemma is causing a slowdown in project development. Developers' inability to secure favorable financing terms is having an impact on present and future planned construction. Of course, this varies by region, with some regions less affected by others. For example, California's residential construction has been greatly influenced by current events, whereby New York City is still seeing a demand for high-rise projects, although even those numbers will be less then in recent years. Many developers are turning more to commercial projects, which in itself also presents challenges, as potential large tenant lease commitments become more difficult to secure.

In general, concerns as to housing, credit, and the economic outlook is affecting the shifting construction picture. As an example, whereas private residential made up 54 percent of the construction marketplace in 2006, by the end of 2007 it was reduced to 42 percent. It is interesting to note the shift toward private nonresidential, 25 percent of construction in 2006 as compared to 32 percent by the end of 2007.

The cause for some good news is that, although we are expecting a slowdown in overall construction, the experts opine that we will also see a shift toward commercial, educational, power, and lodging construction—all very valid wrap-up candidates.

The Current Wrap-Up Marketplace

Traditional workers compensation/general liability wrap-ups are being entertained by a limited but very qualified number of insurance companies. Currently we can count on approximately six different insurance companies who have demonstrated they have the dedicated underwriting capabilities and service resources to handle multi-term projects.

The dynamics are such that each insurer brings a differing appetite to its selection of risk types. We have some insurers that will entertain almost any type of program: i.e., contractor-controlled programs or owner-controlled programs—residential or commercial, etc. Other markets are more selective in their choices. Some have a tendency to write large project types, while others prefer to stay in a more traditional comfort zone.

There are those more comfortable from a risk viewpoint in insuring contractor controlled insurance programs (CCIPs). (As a side note, the advent of more contractor controlled programs is having a definite impact on the state of the owner controlled market. A greater proportion of projects, as compared to years past, are going into CCIPs.)

Also note, aside from insurers' "type of risk" appetite, these six have differing tolerance levels as respects aggregate loss pricing, collateral options, coverage enhancements, and long-term project commitments, to name a few. But there remains one consistency with all insurers that is critical to their risk assessment, and that is the safety commitment and safety resources that the sponsor will be willing to provide on the site. As the market stands in 2008, this one issue takes a majority of the underwriter's time when reviewing the submission provided by the broker. To send in a submission without a detailed section on safety methods, manuals, and resumes of key safety personnel will definitely delay the process.

As for the pricing of primary wrap-ups in 2008, we have seen rates begin to come down as a softening effect takes place in the market. However, as we will discuss later in this article, the general rate reduction in the contractor marketplace may be exceeding the willingness of wrap-up underwriters to recognize that dynamic.

In the past few years, as we saw the rapid growth of residential construction, we simultaneously have witnessed a major increase in markets willing to underwrite general liability-only wrap-ups. Many of these were excess and surplus lines market looking for market share in what was a growth sector. While these markets are still available in most instances, some have segued into other than residential opportunities as a result of the residential construction slowdown.

We have also seen a recent entry into the marketplace of a workers compensation-only underwriter willing to write monoline workers compensation wrap-ups. They (as well as a few other such specialty markets) are staffed with a solid underwriting team and have had some recent successes. They are one of only a few insurers having an expertise (and separate practice) in collectively bargained workers compensation. Although one needs to be aware of issues in separating the underwriting of workers compensation and general liability, these markets can become a critical piece when projects fall under project labor agreements.

Excess Market

A "state of wrap-up report" in 2008 would not be complete without discussing briefly the impact of a softening umbrella and excess marketplace. Here, we have some very good news. On one hand, we have seen an increase in capacity resulting from more insurers (both domestic and international) willing to commit their surplus to writing wrap-up programs. This additional "supply" to the marketplace has also contributed to a softening in rates, whereby the cost of $100 million in limits today is approximate to what we were able to purchase for $25 million in limits a short while ago.

In addition to our expanding domestic marketplace, London is playing a much larger role in providing umbrella terms and upper limit capacity. In some cases, this market softening has been the justification to secure a wrap-up, particularly when price is a driving factor. (However please note from my previous articles that price should not always be the driving factor deciding which way to go.)

Contractor Rates and Wrap-Up Feasibility

Well, unfortunately, we must now turn back to some basics just as a refresher to address this most important factor impacting wrap-ups in 2008. From a pure pricing perspective, the challenge to any sponsor procuring a wrap-up is that the ultimate cost of the wrap-up program is less then what the sponsor would have paid for a traditional program. In other words:

The Cost of Traditional Insurance

  • Subcontractor's insurance cost
  • General contractor's insurance cost
  • Owners' cost in securing an owners' interest policy

MINUS

The Cost of the Wrap-Up

  • Primary wrap-up program cost
  • Umbrella and excess liability cost
  • Brokerage fees

Hopefully, at the end of the day, the wrap-up yields a savings as compared to a traditional insurance program.

Conclusion

What is occurring now poses a challenge to us all. As previously noted above, we can make a general statement that while wrap-up rates are coming down somewhat, we are also beginning to feel the impact of contractor rates reducing at a somewhat quicker pace, hence, the challenge of selling wrap-ups in a dwindling contractor marketplace.

In most states, the largest percentage of the contractor's insurance cost is workers compensation. Certainly, the percentage as compared to the general liability may shift in those jurisdictions where a more tenuous liability environment exists, i.e., labor laws in New York State.

As stated by Mark Hofmann in the March 13 edition of Business Insurance referring to an article published by Standard & Poor's, "Workers compensation insurers are likely to face falling rates this year." Mr. Hofmann goes on to state that:

The article says rates have been declining which is significantly reducing margins of workers comp insurers. The declining prices have not led to weak insurer performance so far because of state reforms that have contained loss costs and led to better earnings.

From California to New York, we have been witness to a dramatic reduction in workers compensation rates for contractors. In those states with traditionally lower rates, recent attempts to pass rate increases have been successful, but not nearly enough to bring those rates to an adequate level.

So now in 2008, we are facing the prospects of contractor deducts for workers compensation (or add alternates—whatever the preference) being lower than in previous years. The prospect of reduced insurance credits must be realistically displayed in our feasibility studies.

An additional burden we are facing in estimating contractor workers compensation insurance costs is a recent phenomenon known as "loss cost rates." In the past, our ability to estimate rates was a fairly simple process (remember when we always used to say "comp is comp"). Assuming we had a trade breakdown budget to work with, we simply went to the manual and applied the proper manual rate to our worksheet. With the advent of loss rating being approved in many more states, the new rate, as shown in the manual, will now be expressed as a pure loss rate only. You will need to estimate the expense factors to promulgate what we knew as the actual "manual rate."

One other dynamic is now coming into play more frequently and that is the impact of reduced rates in the "Owners' Interest" market. In the event a developer, for instance, does not purchase a wrap-up and therefore uses a traditional procurement, they will need to purchase their own liability policy to protect their interests during the construction period. Yes, they will still be named as additional insured under the general contractor's policy; but we all know that is not as full-proof a method as in past years. The owner's interest policy rates have come down dramatically. In the past, some sponsors chose to go wrap-up because of the prohibitive total cost of traditional insurance. Now just the opposite is occurring. The rates have reduced to a level whereby the sponsor may elect to go traditional rather than wrap-up.

So let us go back to our wrap-up savings formula. You can now surmise from all the above that the traditional cost of insurance is coming down while the total cost of the wrap-up, while reducing somewhat (especially in the umbrella and excess policies), is not, in many cases, being reduced proportionately. Again, this has given pause to many potential wrap-up buyers.

As an editorial note, I need to caution everyone these are general comments and not meant to be indicative of every wrap-up opportunity one will see. This may play out differently based on project volume, project type, change in economic fortunes and jurisdictional particulars. I still repeat that the state of wrap-ups in 2008 is very good. Many opportunities abound. We all need to meet the current challenges and play a role in the continuing viability of controlled programs.

In summary, what are the challenges?

  • Underwriters need to be cognizant of the rating environment of the contracting community while still adhering to sound underwriting guidelines.
  • Brokers need to be realistic in their assessment of wrap-up opportunities.
  • Sponsors need to understand their motivation in procuring wrap-ups. It is not all about savings.

Again, opportunities in 2008 are abundant. We just may need to navigate those bumps in the road a little more carefully.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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